Financial Crisis and Contagion: A Dynamical Systems Approach

Abstract:     
The 2007-2009 financial crisis provided need to investigate the causes of systemic risk - also known as contagion - and cures to avoid it. In this article, we use well-established theories in dynamical systems, bifurcation, symbolic dynamics, and chaos, to explain the mechanism behind the contagion in the financial crisis, and provide insight on why conventional economic stimulus including quantitative easing cannot improve sluggish economy and resolve liquidity shortage as well as expected. We further suggest how future economic stimulus should be executed, whether to prevent systemic risk or to get out of a recession. Our contribution is to provide a method to resolve inter-agent liquidity problems in general.

This is a revised and updated version of the article "Systemic Risk, Quantitative Easing, and Chaos: Dynamical Systems Approach" which used to be on this website. The current version will appear in "Handbook on Systemic Risk" from Cambridge University Press.

Number of Pages in PDF File: 26

Keywords: Systemic Risk, Contagion, Butterfly Effect, Bifurcation, Symbolic Dynamics, Chaos

working papers series